SJR 259

Task Force on State and Local Taxation of Electric Utilities

April 28, 1997, Richmond

The task force convened its second meeting on April 28 to receive an extensive report on the tax components of Pennsylvania's electric utility restructuring legislation. Pennsylvania is widely regarded as the first state to address this issue directly in retail competition legislation. A staff advisor to the Pennsylvania Public Utility Commission (PPUC) on electricity and natural gas restructuring economics briefed the task force.

In December 1996, Pennsylvania's "Electricity Generation Customer Choice Act" was signed into law, culminating over three years of regulatory and legislative retail competition activity. The PPUC economist told the task force that momentum for the restructuring law's enactment resulted from (i) electricity's importance to Pennsylvania's economic development, (ii) the failure of monopoly regulation to deliver electricity at moderate rates, and (iii) federal statutory and regulatory support for retail competition. An initial pilot program for five percent of Pennsylvania's electricity customers (in each customer class; e.g., residential, business, etc.) will begin in the fall of 1997, followed by a phase-in of retail competition. All customers will be phased in by January 2001.

Tax revenues were a large issue before the Pennsylvania legislature during the debate over restructuring. Some utilities argued that the state treasury would lose over $800 million annually from its then-current electric utility taxation yield of approximately $1 billion. The PPUC began examining the issue in the spring of 1996 with members of the commission, the Pennsylvania Department of Revenue, the Governor's office and stakeholders in the restructuring debate.

The working group attempted to calculate potential revenue losses to Pennsylvania's general fund from restructuring—principally from the potential inability to collect the Pennsylvania gross receipts tax (GRT) from out-of-state generators selling to Pennsylvania electricity customers. Unlike Virginia, potential local property tax losses (resulting from generating plant write-downs to market value) were not an issue—at least not directly—since Pennsylvania's tax structure permits increasing the tax rate on electric utility property if significant, market-driven assessment declines occur.

The working group's primary objective was to develop a "revenue-neutral" taxation provision for the restructuring bill, establishing a baseline revenue of $984 million (the state's 1995 GRT revenues) until 2002. The working group eventually developed the tax provisions contained in the 1996 restructuring bill. These provisions require that all Pennsylvania retail electricity market participants (including out-of-state generators) pay Pennsylvania's gross receipts tax and ancillary taxes currently paid by electric utilities. Out-of-state electricity sellers must be licensed to sell electricity in Pennsylvania, and it is this license requirement that is intended to establish a constitutionally sufficient "nexus" to Pennsylvania's taxing authority. The tax provisions also contain a "revenue neutral reconciliation" (RNR) feature, which adjusts the GRT tax receipts rising above or falling below $984 million — GRT receipts in 1995-1996. Thus, the GRT rate will float until 2002 to ensure an annual revenue stream of at least $984 million.

The RNR surcharge is the key to the Pennsylvania restructuring bill's revenue neutrality tax strategy. In addition to hedging against the possible success of an out-of-state generator's challenge to the "nexus" provision's constitutionality, as well as simple, price-induced GRT declines, the RNR surcharge covers potential deficiencies resulting from tax revenue declines in (i) capital stock and franchise tax revenues (declines in net worth of electric utilities with stranded investment), (ii) corporate net income tax revenues (shrinking income statements), and (iii) sales and use tax and GRT losses driven by less than full stranded cost recovery during the transition period between 1996 and 2002.

The PPUC staff economist estimated that Virginia's restructuring-related tax losses (state and local) would total approximately $50 million annually ($40 million in locality losses; $10 million in GRT losses), assuming (i) no transition period for GRT losses and (ii) an immediate write-down to market value of stranded plants and no write-ups of transmission or fossil fuel units. However, with a transition period and with a long-term write-down of net generation strandings, he said, this figure could be substantially less than $50 million for years following the start of the transition period.

Members of the task force expressed concerns about adopting restructuring tax provisions modeled after the Pennsylvania bill, questioning the likelihood of Pennsylvania's prevailing on a constitution-based challenge to the mandatory licensing and GRT taxation of out-of-state electricity sellers and marketers. Task force members expressed interest in learning more about the "nexus" issue at its next meeting, particularly from the Office of the Attorney General and from stakeholders in Virginia's restructuring debate. Additionally, the task force agreed to receive a report on restructuring and state and local taxation from DeLoitte & Touche, a public accounting firm engaged by Virginia Power to analyze this issue.